Landlords and mortgage interest relief - have you acted yet?
Landlords have seen may changes in the tax rules applying to them over the last few years. By far probably the most punitive is the mortgage interest relief restriction introduced under s24 of the Finance (No.2) Act 2015.
Now fully implemented and really starting to bite for some landlords, we consider the tax implications and possible opportunities.
The Mortgage Interest Relief Restriction Background
Since 6 April 2017, all mortgage interest and similar costs, have been restricted for all individual landlords letting residential property. From 6 April 2020, no finance costs are allowed as a gross deduction. Instead an income tax reducer will be given. The reducer will be the lower of:
- 20% of the prescribed finance costs not already deducted from property income,
- the property business profits; or
- total income (except income derived from investments) that exceeds the personal and blind persons' allowance.
These rules have been phased in over the last three tax years by providing that an ever decreasing percentage of finance costs will be allowed as a deduction from gross property income.
For 2017/18 only 75% of finance costs were deductible, for 2018/19 the allowable costs were 50%, for 2019/20 the allowable costs were 25% and since 6 April 2020 no deduction has been allowable.
During this period of transition, further relief has been applied in the form of a basic rate (currently 20%) deduction of finance costs from taxable income, as follows:
- for 2017/18 20% of 25% of finance costs were deductible;
- for 2018/19 20% of 50% were deductible;
- for 2019/20 20% of 75% were deductible; and
- for 2020/21, and future years, 20% of finance costs will be deductible.
The restriction of mortgage relief could push effective tax rates on property income to well over 50% by the tax year ending 5 April 2021 for landlords with high loan to value ratios and are or become higher rate taxpayers as a result of how the restriction applies.
It is important for all landlords to understand the application of these new rules and take steps where possible to maximise efficiency to ensure the future of their property business.
Many landlords believe it is too late to act and are considering selling up their portfolios at capital gains tax rates of up to 28%.
Tax Planning Opportunities
Whilst the new rules effect all landlords with finance arrangements, larger unincorporated property businesses and those reinvesting profits into further acquisitions are likely to feel the pain more. Property tax planning can have significant Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT) implications.
Other more practical issues include the potential need to rearrange finance arrangements and legal documents including land registry records and tenancy agreements. The whole process can be expensive, very time consuming and stressful.
Many landlords are also hesitant due to the high potential tax exposure and differing views as to what is feasible. Property is largely an unregulated area which can lead to a lack of clarity when it comes to tax and legal issues.
CGT and SDLT Relief on Incorporation
Incorporation relief is a Capital Gains Tax (CGT) relief that can apply where a business is transferred from an individual or partnership to a limited company as a going concern.
There have been many tax cases that challenge the presence of a business where property had been transferred to a company.
The most prominent case which went in the taxpayers’ favour is Elizabeth Moyne Ramsay v HMRC  UKUT 0226 (TCC). This case has served as a benchmark in considering whether a business exists for incorporation of a property business.
It is also possible to seek a pre transaction clearance from the stamp office where it is considered that Stamp Duty Land Tax (SDLT) does not apply. This generally applies where the business being transferred is carried on in partnership.
Where a property enterprise serves as a lifestyle business, incorporation may not be suitable due to the double taxation of income for the company and then the shareholder director(s).
Where landlords are considering restructuring their portfolios, disposals post incorporation could be made tax neutral, releasing more funds for further investment.
Potential changes in legislation for the tax treatment of corporate finance in property businesses, treatment of investment companies could once again level the playing field.
Any landlord considering the incorporation of their property business should take full tax advice on the suitability of such arrangements in their particular circumstances. It is possible to seek HMRC clearances to give you certainty that they will not challenge transactions carried out as described to them.
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Published: 31st August 2020